Macro Markets Analysis

Economy The Q3 GDP data showed the expected sharp acceleration of the US economy, although we would have expected even higher growth rates. The structure, on the other hand, was mostly in line with what we had deduced from the monthly indicators. Car sales contributed one percentage point, and changes in inventory (almost) another one to the annualised growth rate of 3.5%. The contribution from residential investments was 0.5 percentage points.The economic growth in the areas mentioned was either due to stimulus programmes in the public sector or to a process of adjustment, and thus only temporary.

The US version of the scrappage premium has already expired, which means that we will see no more support from this front. After the end of the programme in August and the subsequent slump in car sales in September, the most recent data showed a minor increase in October. This suggests that the negative effect of the advanced purchases on the following months was already realised in September, and the decrease in car sales in the fourth quarter should be substantially lower than the increase in the third quarter was.

The second growth driver of the third quarter will be of temporary nature as well, albeit for longer than the scrappage premium. The inventory depletion only slowed down in the third quarter, but will soon - probably this quarter - come to a complete halt. This is tantamount to yet another positive contribution to GDP growth, which may even exceed the one in the third quarter. However, this scenario does not reflect any recovery in consumer demand, but rather it is an adjustment process. In order to draw down the inventories, it was necessary to lower production below the level of demand. Once the targeted inventory levels have been reached, production is realigned with demand. During this period of time (which is temporary), production increases at a higher rate than consumer demand. We see the massive increase in the ISM index in this context. The index has recently increased to a three-year high, which is quite at odds with the picture all the other indicators are painting of the US economy.

Another temporary factor is the USD 8,000 tax allowance for first-time buyers of homes, which was passed by the US government in spring. This scheme has surely contributed to the gradual increase of home sales since March.

The monthly sales of new homes may not fully reflect the development of the GDP component residential investments; in fact, home sales started to pick up already in the second quarter, whereas the GDP component was still on the decline. But in the third quarter, residential investments contributed 0.5 percentage points to GDP growth. This growth wave was certainly due to the stimulus programme of the government. The programme will expire in November, but the ratification of its extension to April 2010 is imminent. At the end of the day, this step will only shift demand on the time line, at best increase it marginally. It is very dubious whether the extension will support the continued increase in home sales, because the group of people who will be persuaded by the programme to buy a home after nine, ten, or eleven months should be smaller than the number of people who called upon the programme within the first eight months. At best, the extension will stabilise purchases and only trigger a decline after the end of the programme. Hopes are that other segments of the US economy will then make up for this decline.

We believe that the quarterly growth rates of the US economy will start falling in the first quarter of 2010, because the contributions from the changes in inventory and from home sales will recede, and the other areas will fail to compensate fully for this shortfall. This is due to the fact that private consumption will remain subdued until far into the year 2010 because of asset losses in the property sector and the rising unemployment rate. At the same time there are unutilised capacities in the corporate sector, which means we do not expect any large-scale investments in the foreseeable future either.

Monetary policy In its latest meeting the open-market committee of the US central bank decided not to make any changes to the monetary policy. The assessment of the economy improved slightly, but the committee continues to expect economic activity to remain weak for the time being. This is why they apparently did not see any reason to even prepare markets for a change in policies. This course is not likely to be adjusted any time soon. As mentioned earlier, the US economy may be past the worst, but it is in for only moderate growth rates next year. This will enable the Fed to take the pedal only slowly off the metal so to speak. In the initial phase, the central bank will have to withdraw the liquidity it had previously injected into the market. Although this does not have to happen before an interest hike, it would be the logical procedure from a chronological point of view. But since the Fed will be buying securities until March 2010, we only expect a slow withdrawal of liquidity for example in the form of reverse repos from the second quarter onwards. Even if this can be seen through swiftly because the negative effects on the bond market are limited, the process is likely to be long. Therefore the earliest point in time for an increase of interest rates is the third quarter of 2010, in our view. In this scenario we already assume that the withdrawal of liquidity has not come to an end by then. We find it difficult to envisage a faster approach, i.e. a more aggressive exit strategy. The decisive factor for the speed of the liquidity withdrawal will be the reaction of the bond markets. Any substantial yield increase would be regarded as tightening of the monetary situation and would slow down the liquidity withdrawal, which would ultimately put interest rate hikes off as well. It is difficult to imagine that the bond markets would not react to the liquidity withdrawal by the Fed, especially because it will happen within an environment of active issuing by the public sector.

Bond marketThe US bond market has settled within a certain bandwidth. We think that yields are kept low by bond purchases made by the Fed, by the continued cautious stance many investors are taking, and by the generally high level of available liquidity. The former are expiring whereas the issue volume in the public sector will remain high. For next year we expect a budget deficit of more than 10% in terms of GDP. We can only reiterate our point of view, which is that in the absence of any additional liquidity injections by the Fed and in fact under the premise of liquidity withdrawals at a later stage combined with high issue volumes, government bond yields should rise. The likelihood of foreign investors filling in is low, at least at current yields. The financing needs of governmental issuers will be globally high, and US government bonds will have to offer a premium in order to attract foreign capital.

US dollarEURUSD recently passed the 1.5 mark for the first time since August 2008, but only for a little while. Weak equity markets and profit-taking after the decline of the US dollar pushed EURUSD back below 1.5 again. We expect the dollar to depreciate again and believe that it has not seen its low in the current cycle yet. At the same time however, we have strong reason to believe that the amplitude around the sliding exchange rate of the dollar will intensify. Most importantly, the majority of investors are short in the dollar, i.e. positioned for the depreciation of the currency. This is due to essentially two reasons: the deterioration of the environment (extremely expansive monetary policy, rapidly growing budget deficits, as is common knowledge), and the low interest rates, due to which the US dollar has become suitable as financing currency again. One indicator of this situation is the fact that lending of US banks to banks abroad has picked up again. However, this only captures a part of the suspected carry trades, as US banks/investors surely also use their own currency to finance investments with higher yields. Given that the current exchange rate expectations are rather asymmetric (i.e. one-sided), the risk of abrupt regroupings in case of an unfavourable development of the exchange rate increases. Apparently the market has been picking up on this increased risk as well, seeing that the implicit (i.e. expected) volatility has already risen, albeit from low levels.